An Empirical Test of Purchasing Power Parity Theory for Canadian Dollar-US Dollar Exchange Rates

Abstract

The paper examines the long run movement between Canadian dollar and US dollar exchange rates. The study uses monthly data for the period 1995:01 to 2008:08 and employs the Engle-Granger cointegration test. Our analysis suggests that the absolute purchasing power parity (PPP) does not hold, indicating no long run relationship between the observed exchange rate and PPP rate. The result shows that there is no cointegration between actual exchange rate and PPP rate, suggesting that there is no long run relationship between Canadian dollar and US dollar exchange rates. A close examination of the data shows that output prices move more slowly, and is evidence against PPP in the short run. We acknowledge that the study period may be small to capture the existence of a long run relationship. However, our regression analysis suggests that the relative price movements are significant in explaining the actual exchange rate between US and Canada.

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